The Climate Financial Risk Forum (CFRF) has published a second round of guidance to support firms as they develop their approaches to addressing climate-related risks and opportunities.
The CFRF was established in March 2019 by the PRA and the FCA. It is made up of representatives from banks, insurers and asset managers and aims to share best practice and analysis, in order to advance thinking on how firms can better manage the risks posed by climate change and support the transition to a net-zero carbon economy.
A first round of guidance was published in June 2020, consisting of a summary paper and separate chapters on Disclosures, Innovation, Scenario Analysis and Risk Management. It provided practical tools, experience, knowledge and case studies for firms to use as they developed their climate risk strategies and approaches.
Evolving approaches – by industry, for industry
The latest publications (Session 2 guides) by the CFRF's Working Groups comprise a total of 10 outputs as follows:
- Risk management – risk appetite statements (PDF 1.0 MB), use cases (PDF 1.5 MB) and climate risk training (500 KB)
- Scenario analysis – implementation guide (PDF 3.2 MB), data and tools providers spreadsheet
- Disclosure – case studies (PDF 1.2 MB), managing legal risk (PDF 422 KB)
- Innovation – commentary report (PDF 605 KB), case study videos
- Climate data and metrics – guide (PDF 1.2 MB)
The Scenario Analysis Working Group also expects to launch an online narrative tool to support smaller firms in Q1 2022.
The outputs incorporate current best practice and are written `by industry, for industry'. As such, they do not constitute regulatory guidance and do not necessarily represent the views of the regulators. However, as in 2020, we can expect them to be used as the “go to” documents for firms.
Key messages from the Forum
- The approaches are not intended to be “one size fits all” – firms are expected to review, digest and adapt good practices to their specific requirements
- The guidance is designed to be practical – firms are strongly encouraged to read it and use it as much as possible
- Climate risk should be embedded into risk management and business strategy – this will enable firms to manage the downside, benefit from the opportunities, and play a part in helping limit climate change
- Firms are encouraged to be strategic and ambitious and make every effort to do more around climate risk
- The greatest risk around climate change is inaction – firms must take action, even if it is not perfect.
For more detail by workstream, see below:
- Climate risk should be treated as a cross-cutting risk type that manifests through most of the established standalone risk types and should be incorporated within the existing risk management framework
- Firms must do more around climate risk – it should be embedded into risk management and business strategies.
- The PRA and Bank of England expect climate risk to appear on the balance sheet.
- Metrics can be used to track progress against targets. A bank's metrics should be aligned with its existing risk management practices and the nuances of its individual risk profile.
- A bank's metrics should be in line with its commitments, strategies and corporate plans and can be tracked with a series of annual targets.
- Analysis in the 2021 GARP Risk Institute survey is a benchmark for the industry's progress on climate scenario analysis.
- Qualitative information provides understanding, consistency, and comparability by providing guidance on how to use scenario analysis to assess financial impacts and inform strategy/business decisions.
- The report provides four benchmark scenario parameters and appropriate assumptions for firms to develop their scenario analysis approach.
- Scenario modelling assumptions may limit the effectiveness of outcomes. Firms must understand the limitations of their assumptions when analysing scenario outcomes.
- The transition risk of corporate lending profiles in relation to oil and gas and energy intensive sectors is likely to be exposed to the variables present in NGFS disorderly scenarios.
- The physical risk of corporate lending profiles is best analysed at a more granular level e.g. consider specific geography.
- Financial aspects of materiality are not always the most appropriate consideration.
- Perceptions of materiality by investors may evolve quickly and in the short-term institutions may elect to make disclosure on a precautionary basis based on their expectations of what investors will consider material.
- Consideration of climate-related financial risks and how they are assessed and disclosed will be an audit focus from 2021.
- Auditors should be aware of any TCFD processes being followed and the outputs and proposed disclosures arising from them.
- The potential opportunities associated with the move towards a net zero economy are underappreciated.
- Managing climate risks requires a strategic approach. Regulators and industry must work together to ensure the development of scalable innovation.
- Streamlining of climate metrics into standardised forms is required to improve their effectiveness?
- Carbon-exposure metrics do not provide a sufficient view of the transition risk a portfolio experiences. Additional information is required to adequately price this risk.
- Metrics must be standardised in order to ensure the effectiveness of system-wide stress tests in identifying systematic risks, and to evaluate the effect of firms' actions on the real economy.
- Climate-related metrics, such as carbon intensity, do not necessarily translate directly into financial impact in the case of a well-below 2C transition. Some firms may pass on the financial impact to their customers and others may be forced to absorb the cost.
- The impact of decarbonisation differs between sectors – some industries can pass on the cost to consumers with no asset value effect, whereas others experience severe asset devaluation.
- A firm's carbon footprint is not necessarily correlated with physical risk exposure within a given portfolio.